Fannie Mae Profiting as Market Middleman Angers Lenders

Fannie Mae Profit as Market Middleman Angers Lenders
The Fannie Mae headquarters stands in Washington. Photographer: Andrew Harrer/Bloomberg

Fannie Mae is snatching potential profits away from mortgage lenders as it posts record earnings that are fueling industry concern the government-backed company is regaining its swagger even as lawmakers plot its demise.

The company has ramped up its purchases of home loans from lenders for cash, in the process cutting out originators from the more profitable business of creating and selling bonds backed by the debt. About 31 percent of the $305 billion in new Fannie Mae-guaranteed securities in the first four months of this year were tied to so-called cash window purchases, almost triple the share in early 2011, according to data compiled by Bloomberg and JPMorgan Chase & Co. analysts’ estimates.

The shift is morphing Fannie Mae into more of a middleman between homeowners and the bond market, a role typically played by originators or the larger banks that buy their loans such as JPMorgan and Wells Fargo & Co. The trend underscores growing tension between the Washington-based company and lenders concerned it’s trying to exploit its strength in a market where it backs almost half of new bonds to repay taxpayers, rebuild its brand and survive.

“It’s a defend-the-Alamo philosophy,” Bill Dallas, chief executive officer of Skyline Financial Corp., a Calabasas, California-based lender, said in a telephone interview. Still, “they shouldn’t engorge themselves in profit if they can share that with the lenders that take the risk.”

Maintaining Dominance

Lenders are also concerned that Fannie Mae is working to maintain its dominance in the market over Freddie Mac, a company with a similar mission that was also seized by the U.S. in 2008, according to five mortgage executives who asked not to be named to preserve their relationship with the company.

Fannie Mae has “no goal relative to market share, except to reduce it,” Andrew Wilson, a spokesman, said. The firm has repeatedly said that it wants policy makers to decide how to reform the mortgage finance system and its future as quickly as possible, and is embracing directives by its regulator that are meant to bring in more private capital in the meantime and reduce its role, he said.

“We don’t play this big of a role because we want to,” Chief Executive Officer Timothy J. Mayopoulos said last month in a Bloomberg Television interview. “It’s really because we need to in order to provide liquidity and funding to the market.”

Bipartisan Legislation

President Barack Obama and both Democratic and Republican lawmakers in Congress have said they want to wind down the two companies and shrink the government’s share, currently about 90 percent, in the market. No one has yet put forward a plan, though lawmakers in the Senate are currently working on bipartisan legislation. Republicans in the House of Representatives are also writing a bill. All of the measures are likely to include provisions intended to eventually eliminate Fannie Mae and Freddie Mac.

The expanded use of Fannie Mae’s cash window reflects originator preferences and is a responsible practice, according to Zach Oppenheimer, a senior vice president who heads customer engagement at Fannie Mae. It prevents some inexperienced lenders from creating its bonds because they haven’t shown the appropriate operational and financial resources, he said.

An originator issuing mortgage-backed securities must be prepared to hold on to loans before bonds are created, pool them with the correct disclosures needed by investors, and cover missed payments as a servicer in the event of borrower delinquencies, he said.

Helping Succeed

“We don’t want counterparties to fail at pooling loans into MBS, and our controls are designed to help them succeed,” Oppenheimer said in a telephone interview.

Others see different goals, such as a desire to give Fannie Mae a chance to earn profits and build a business that may outlast an eventual mortgage-finance overhaul that Barclays Plc analysts said in a May 15 report could leave it without its traditional advantages if it survives.

“If they can get a nickel on any avenue they will do it,” Andy Jaymes, principal at Reston, Virginia-based Jaymes Financial Inc., which helps clients buy and sell loans including mortgages, said in a phone interview. It’s good news that Fannie Mae and Freddie Mac are profitable, he said.

Doubt over Fannie Mae’s motivations reflect its past, when banks and mortgage insurers formed a lobbying group called FM Watch to seek to rein in the firm and Freddie Mac. Later, books on the financial crisis -- including “Guaranteed to Fail” by four New York University professors and “Reckless Endangerment” by Gretchen Morgenson and Joshua Rosner -- put Fannie Mae’s political might as among the causes for the worst housing slump since the 1930s.

Public Brand

There are signs the company is seeking to rehabilitate its public brand as Congress and the Obama administration debate its future.

The top of its website features links to a “progress report,” filled with information about its return to profitability and help for homeowners. It includes photos of smiling people, with one painting a white picket fence and a child clutching a soccer ball in a yard.

“Nothing in the progress report is different than what we’ve been saying for the last four years,” Wilson said. “We think it’s important for people to understand what we’re doing given the extraordinary investment by taxpayers.”

The company was formed in 1938 as part of President Franklin D. Roosevelt’s New Deal intended to help lift the country out of the Great Depression. It was then split off from the government in 1968 while retaining an aura of taxpayer backing. The U.S. seized Fannie Mae and Freddie Mac in September 2008 and began standing behind them more explicitly to prevent their collapse from further roiling housing.

Largest Profit

As home prices began rebounding after a five-year slump, Fannie Mae reported the largest annual profit in its history in 2012, with its net income reaching $17.2 billion, and the company’s $8.1 billion first-quarter profit was its best ever.

After its latest payments to the Treasury Department, Fannie Mae will have sent a total of $95 billion, though it still owes $117.1 billion to the U.S. after taking capital infusions to survive that can’t be repaid. The current terms of its bailout agreement require essentially all its profits have to be sent to the U.S. as dividends.

Hedge funds including John Paulson’s Paulson & Co. are lobbying for a privatization of Fannie Mae and Freddie Mac that could benefit preferred shares they’ve bought. Fannie Mae’s 8.25 percent of preferred shares rose 10 percent today in New York to $6.14 and have climbed from $1.67 at the end of last year. The securities have a par value of $25. The common shares, which rank lower, gained 41 percent today to $2.97 and are up from 26 cents at the end of 2012.

Ensure Viability

“The Fannie Mae execs are going to do as much as they can to ensure the viability of the company and ensure that it survives,” Kevin Barker, an analyst at Washington-based Compass Point Research & Trading LLC, said in a phone interview. “To the extent they are operated like a private corporation they may act like one,” he said. Still, the “priorities and strategic goals may not be in the best interests of the housing market as a whole.”

While Fannie Mae and Freddie Mac’s recent earnings are positive for taxpayers, the record profits should also be considered a signal that the mortgage-finance system is being transformed at a pace that’s too slow, according to David Stevens, president of the Mortgage Bankers Association.

“We need to be really clear on what the outlook for these two companies is,” Stevens, who is also a former Federal Housing Administration chief and Freddie Mac executive, said in a telephone interview. “If it’s privatization, maybe driving toward the most profits make sense. If it’s not, more work needs to be done on preparing for their future.”

Sharing Risks

His group is pushing for their regulator to move faster to offer private firms the chance to get paid for sharing their risks, and for a restructuring to allow for a merging of Fannie Mae and Freddie Mac securities. Along with being useful in the future, a combination would offer Freddie Mac a greater ability to compete on a variety of fronts, he said. Fannie Mae now has the upper hand because the greater trading volumes of its bonds means they sell at higher prices, he said.

Denise Dunckel, a spokeswoman for the Federal Housing Finance Agency, the company’s overseer, declined to comment, as did Brad German, a spokesman for Freddie Mac.

Fannie Mae, which guarantees $2.8 trillion of single-family mortgage debt, backed 48 percent of bonds issued in the first quarter, with most of the rest split between Freddie Mac and U.S.-owned Ginnie Mae. Freddie Mac issuance through April represented 58 percent of Fannie Mae’s, down from 75 percent in 2006 and 2007, according to FHFA and Bloomberg data.

Guarantee Fees

While Fannie Mae raises its guarantee fees at the direction of its regulator, the company also is offering to hold them steady over several months for some lenders that promise it certain volumes, according to the mortgage executives. One consequence of that practice may be to help Fannie Mae avoid losing business to Freddie Mac.

Fannie Mae is offering the “reservation pricing” to help lenders manage their risks and while it now offers the program only to some of its mortgage-bond issuers, it plans to gradually roll it out more widely, Wilson said. It no longer offers the longer-term contracts that Fannie Mae and Freddie Mac once used to gain market share, he said.

Fannie Mae’s cash window is used by more than 1,000 lenders, while its issuers, which swap loans for securities backed by them, total only about 150, JPMorgan analysts led by Matthew Jozoff wrote in a May 10 report.

Making Money

While the company doesn’t disclose how its growing use affects its financial results, “it’s very clear that Fannie Mae is really encouraging it and the obvious reason is that Fannie Mae makes more money in that route,” according to David Lykken, the managing partner of the Austin, Texas-based consulting firm Mortgage Banking Solutions.

That’s because bonds backed by loans with specific characteristics are worth more in the market. Securities filled only with loans of less than $85,000 can fetch about 1 cent on the dollar more than generic debt because buyers see them as being less likely to refinance when rates drop, according to Credit Suisse Group AG data.

In addition to the restrictions it places on companies doing business directly with it for the first time, Fannie Mae is also driving lenders to its cash window by increasing the prices it pays relative to what generic securities fetch, according to three lender executives.

Cash Window

Fannie Mae’s Oppenheimer said that lenders tell him they often prefer the cash window for reasons including its simplicity, and that the pricing reflects what’s happening in the mortgage-bond market.

“We act as a conduit,” he said.

Lender complaints over Fannie Mae’s cash window echo concerns that emerged regularly before its seizure that the company was exceeding the mission embedded in its Congressional charter, said Don Brown, president of Denver-based Secondary Interactive, which provides services to mortgage lenders.

“There are those who say they are positioning themselves for market dominance,” he said. While Brown said that he’s not quite as skeptical of the company’s motives, “that type of behavior would be especially concerning in a market where they are effectively government agencies.”

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